Heckerling Leaves Open Questions

It has often been said that the path to knowledge begins with knowing what you don’t know. As usual, this year’s Heckerling Institute helps put the estate planning attorney on the path to knowledge by highlighting how much we do not know.

Section 2001(b)(1) calculates the estate tax in the year of death as the sum of the tax on the taxable estate and the tax on the amount of adjusted taxable gifts over the aggregate amount that would have been paid on the gifts if they had been taxed as part of the decedent’s estate in the year of death. Section 2001(b)(2).

This works fine in a situation of a rising applicable exclusion. However, in the situation of a declining applicable exclusion, as we may have in 2013, it may cause an estate tax on prior non-taxable gifts.

Example: John has $6 million and gifts $5 million in 2011. He dies in 2013 with $1 million.

Section 2001 is intended to add back the prior gifts so that the $1 million is taxed at the rate of 50% rather than an effective rate of 34.58%.

Instead, Section 2001 could be read to tax the situation as a $6 million estate, or $2,940,800 less the unified credit of $345,800, which would result in $2,595,000 in tax.

The speakers at Heckerling were uncertain how the clawback issue would be resolved. However, they and I think it would be grossly unfair to give an applicable exclusion of $5 million in 2011 and 2012, only to have the decedent’s estate discover that those gifts resulted in an estate tax at the decedent’s death in 2013.

Of course, even if the clawback does exist, one would still be better off to use their $5 million applicable exclusion in 2011 or 2012. At least the appreciation on the asset would escape transfer taxes.

In our example, let’s say John’s $5 million of gifts in 2011 appreciates to $10 million by the time of his death. Thus, without the gifts in 2011, John’s estate would be $11 million and the tax would be $5,395,000, after use of his exclusion. Even with application of the clawback, the John’s estate would have saved quite a bit by doing the gifting. The tax would be $2,595,000 rather than $5,395,000.

As the days and hours ticked down in 2010, we faced a great deal of uncertainty on the extension of EGTRRA. With the potential “clawback,” we likely will be facing at least as much uncertainty in the waning days of 2012.

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